Commodities 2023 Outlook: Let’s Not Forget the Weather, Huh?

Much has been said about the impact central bank rate hikes, a recession in the West and the political fallout from Russia’s invasion of Ukraine could have on commodity markets in 2023. With the new year almost here, let’s look at something that hasn’t been talked about as much and might be more influential in the near term on raw materials prices, particularly those of energy: the weather.

One of the coldest Arctic events on record is unfolding across the bulk of the United States, including Texas and the Southeast.

The polar outbreak is bringing the sort of chill to many areas reminiscent of the historical cold seen in 1983, 1989, 2000, 2010, and 2014. Blizzards have pounded regions from the upper U.S. Midwest to the Northeast. Even areas of the nation as far south as Houston, Texas, have seen low 20s or high teens Fahrenheit levels (minus 5 to minus 8, celsius) at some point.

The problem is, with weather being weather, these forecasts and conditions can change on a whim and lead to massive price fluctuations, as they have with prices of natural gas, one of the main sources for heating in the United States.

As of now, some of the lower 48 US states are experiencing among the coldest temperatures for late December. Other states, meanwhile, are witnessing a sustained period of notably mild weather that began concurrently with the Arctic blast and could be around till the last few days of 2022.

If that’s not perplexing enough, the major weather forecast models, including the ECMWF longer-range model for Europe, continue to support the notion that another significant, widespread period of frigid conditions could be on tap during the second week of January.

So, what do all these mean for the energy commodities that Americans rely on for heating, from natural gas to heating oil?

Natural gas, for one, has been subjected to some of the worst market volatility since the first quarter of 2022, when the Ukraine invasion began.

Prices of the fuel experienced their lowest close in nine months last week, with benchmark January contract settling on Thursday at $4.99 per million British thermal units on the New York Mercantile Exchange’s Henry Hub — just under the key $5 per mmBtu support. January gas did recapture the $5 threshold by Friday’s close, but the rebound was nominal. The tumble has brought the year-to-date gain in benchmark gas prices to just about 33%. In August, they stood at almost 170% when benchmark gas hit a 2022 peak of $10 per mmBtu.

The mix of freezing and balmy weather has huge implications for natural gas consumption.

Originally, industry analysts projected that heating demand could eat up 500 billion, or bcf, from storage over the last three weeks of the year — meaning that each week would average a drop of 167 bcf in volume. For an idea of how big that is, the last time weekly gas draws were bigger was 10 months ago, when 190 bcf was used up during the week to Feb. 12. Such inordinate demand for heating could make significant dents on the deficit already present in the five-year average for gas inventories.

However, the first of the three weeks only brought only 87 bcf in gas burns, even lower than the revised estimate of 93 bcf for that week.

In spite of that, gas prices are likely to end the year off their lows, due to the mixed weather outlook, according to Houston-based energy markets consultancy Gelber & Associates, which says:

“While there does appear to be a period of moderation in temperatures that follow the peak of the cold early next week, the same longer-range weather models and indicators that accurately predicted the current Arctic intrusion are already pointing to another winter storm of similar magnitude to take place around the middle of January potentially.”

“With temperatures in some areas of the Central and Southern Plains set to see readings that are more than 40 degrees below-normal during the outbreak, natural gas well production freeze-offs in excess of 5 bcf per day are likely to be on the table. Spot prices for physical natural gas are poised to soar over the course of the next ten days at most key pipeline hubs across more than half of the country.”

While natural gas is known as the “Bucking Bronco” of commodities due to its volatile nature, daily gyrations of 7% to 10% a day over the past couple of weeks have left even veterans in the trade nonplussed.

What’s more spectacular is that momentum has often built on the awkward or, if you will, “wrong side” of the trade. Case in point: The 11% plunge in the benchmark gas contract week-to-date when “the looming Polar outbreak isn’t small potatoes,” said Gelber in its note.

“However, the market is more focused on the period of less cold temperatures during the interim,” the consultancy said.

So, what could be the flip situation for the market then? As said earlier, NYMEX gas prices went as high as $10 per mmBtu in August, when the weather wasn’t as hot as compared with the cold now.

Adds Gelber:

“One thing is certain: if hedge funds were invested in long-positions in NYMEX gas futures, prices would probably be soaring under the current weather conditions. If the $7-teens/MMBtu area were violated by a wave of buying this week, it could trigger a short-squeeze that could send NYMEX gas futures prices spiking significantly higher. However, so far, any short-squeeze efforts have been contained.”

And rallying gas futures could also lead to rallying heating oil, a component of crude oil. Heating oil hit a record high of $4.4898 per gallon in June, forerunning the summer rally in natural gas. At Friday’s settlement, heating oil’s front-month contract on NYMEX closed at $3.2661 per gallon. It signaled heating oil’s potential to rally in sympathy with crude oil, which jumped a combined 11% over the past two weeks.

Crude oil’s rally on Friday came on the back of threats by Russia to cut production by between 500,0000 and 700,000 barrels per day as President Vladimir Putin’s government reacted adversely to the price cap of $60 per barrel placed on Russian exports by the G7 grouping of countries.

Still, on the subject of winter, Ukraine’s leaders were reported this week to be bracing for the possibility that Russia will sharply escalate the war against their country in a winter offensive as Moscow tries to turn around losses on the battlefield and limit political backlash at home.

Heightened fighting in Ukraine often leads to a spike in crude prices as the trade worries not just about geopolitical fallout but also about a further squeeze in the availability of Russian oil to the world after the West’s ban on all energy imports from the country, and the G7’s $60-per-barrel price cap set on each barrel exported by Moscow. Crude prices had hit 14-year highs of just over $130 a barrel for U.S. West Texas Intermediate crude and a touch below $140 for global benchmark Brent in March. As of Monday, the two were at around $75 and $80 per barrel, respectively.

Despite suffering severe setbacks over the first 10 months of war, the Russian military is now laying plans for mass infantry attacks akin to the tactics employed by the Soviet Union during World War II, Mykhailo Podolyak, an adviser to the Ukraine government on the current war, said in comments carried by the New York Times at the weekend.

The comments came as Ukraine’s top military and political leaders warned in a series of recent interviews that Russia was massing troops and armaments to launch a renewed ground offensive by spring that very likely would include a second attempt to seize Kyiv, the Ukrainian capital.

One major caveat for the early 2023 weather outlook: Seasonally, the intensity lasts over just three months, plateauing with the onset of spring. Also, the outlook can change on a whim, as said earlier.

So, bulls don’t bet the house on the weather. And bears, don’t underestimate Mother Nature.

Happy Holidays and a Blessed New Year to all!

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.